Financial Tightening and Its Real-World Consequences: Lessons from Regional Banks in Recent Portfolio Adjustments
March 20, 2023
The collapse of two sizable, regional U.S. banks – and the decisive and unprecedented response by the FDIC and Treasury Department – showcases the real-world, practical consequences of rapid financial tightening. As a result, we are enhancing the overall quality and resilience of our portfolios: cutting net exposure to stocks and credit, amidst unusually elevated uncertainty.
According to Haver Analytics, BlackRock, and the Federal Reserve Board: as of February 28th, regional banks were responsible for nearly 50% of American business and consumer lending.
Source: Haver Analytics, BlackRock, and Federal Reserve Board (February 2023)
These borrowers now face the likelihood of heightened cost of capital, further deposit leakage, and an increased need to over-collateralize. Such cracks across the sector may instigate brake-taps in lending, and less lending could represent real financial tightening.
Source: Bloomberg, US Loan Officer Survey (March 2023)
From our portfolio-centric perspective: regardless of whether a formal recession materializes, these banking-related developments – along with recent earnings and economic data – suggest that the potential downside risks for stocks have become more pronounced.
Source: Wall Street Journal (March 2023)
This situation has greater potential to adversely impact the economy than the slow(er) drip of the Fed’s ongoing, target rate increases – which should, in our view, persuade the Fed to soften the tone (and implied actions) of its recent, hawkish messaging.
We feel that the market does not yet properly reflect the risks associated with contracting, bank lending conditions – and their ramifications for the broader economy. Thus, we are repositioning portfolios, as follows:
